Tether (USDT) offers the familiarity and stability of the dollar, but in digital form, moving across blockchain networks. As one of the first stablecoins of its kind, Tether is the No. 1 stablecoin by market capitalization.
Nonetheless, Tether’s reputation has been tarnished, to say the least. In the case of a bank run, could every Tether holder redeem their stablecoins into US. dollars without USDT’s price collapsing? The entire decentralized finance (DeFi) ecosystem depends on it.
Tethering Financial Stability in a Volatile World
Of all activities on blockchain networks, what is one that is treasured the most? Simply put, depositing a cryptocurrency as a collateral in order to get a loan. This is the mainstay DeFi service available on hundreds of dApps, some of which are DAOMaker, Curve, Aave, or Compound.
The problem is when people use cryptocurrencies to collateralize their loans, they typically have to over-collateralize them multiple times. This is necessary because novel cryptocurrencies, with drastically lower circulation compared to any fiat currency, are prone to wild price swings. Otherwise, the loan could easily strike liquidation price.
Over-collateralization neutralizes this problem, but only to an extent, as demonstrated during the Terra (LUNA) collapse. As a result, investors have a greater peace of mind when using stablecoins, anchored to fiat currency in a one-to-one basis
That means one Tether can be redeemed for $1. The upshot is that stablecoin-backed loans don’t require over-collateralization, making DeFi dApps more accessible to a wider range of income brackets. The demand for this stability was Tether’s main driver since it launched in 2014.
In the summer of 2020, when Ethereum started hosting viable lending dApps, Tether went into parabolic demand overdrive. At one point, in April 2022, it was worth $83B.
But this begs an important question. If Tether was holding for six years well under the $5B market cap, how was it possible that it could be redeemed a much greater amount so shortly after?
How Do USDT Stablecoins Work?
As noted previously, Tether tokens are pegged to the value of the dollar, USD, in a one-to-one basis. Tether issuance and redemption process follows five steps:
- According to the know-your-customer (KYC) rule, an individual, merchant, or exchange issues a request for USDT by depositing fiat currency into Tether’s bank reserve account.
- Upon that request, Tether issues USDT tokens, representing USD value, which are sent to the requester’s wallet address. Minus the transfer fee, the amount is equal to the amount of USD deposited.
- As digital assets, users can store or transfer USDT tokens between wallet addresses and supported blockchain networks. Investors typically store USDT in their wallets as they prepare to buy cryptocurrencies, such as Bitcoin (BTC). When this happens on centralized exchanges, it is an indicator that major whale action is happening, resulting in market speculation.
- USDT holders can at any point redeem their Tether for USD at Tether.to, or at any cryptocurrency exchange serving as a mediator.
- Once Tether tokens are redeemed, they are removed from its circulating supply.
Only Tether is in charge of issuing or removing its tokens from circulation, making it a centralized stablecoin reliant on the traditional banking system. But, is Tether fully backed with redeemable cash reserves and other liquid assets or not? It’s a question regulators and law enforcement officials in the U.S. have investigated.
Tether (USDT) Origin
Tether stablecoin originated in the cryptocurrency exchange space. The Hong Kong-based company iFinex is the owner of both Bitfinex exchange and Tether. Way before Ethereum dApp ecosystem developed, in 2014, farseeing crypto enthusiasts launched Tether.to platform to tokenize fiat currency.
Tether’s main purpose is to facilitate money transfers 24/7, near-instantly and affordably, something that is not possible with the cumbersome SWIFT system. Case in point, sending international payments by wire has to be confirmed by multiple banks, resulting in delays and extra fees.
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With Tether, its transfer speed depends on the performance of the blockchain network itself, whether it is Ethereum, Tron, or Avalanche. There have long been questions about the links between Bitfinex and Tether.
Tether’s Reputational History
Tether first came under greater scrutiny when Bitfinex used Tether (USDT) to mask $850M that went missing. In April 2019, the New York Attorney General instructed iFinex to stop moving USDT from Tether’s bank accounts to Bitfinex’s bank accounts. The attorney general estimated that at least $700M was depleted from Tether’s reserve.
Tether had to pay an $18.5M fine to settle the probe two years later. In October 2021, the Commodity Futures Trading Commission (CFTC) issued an order for Tether to pay a $41M fine over its misleading claim that USDT was fully backed by U.S. dollars.
At the congressional hearing on stablecoins in December 2021, Tether failed to send any representatives. Needless to say, this was quite odd given the fact that Tether was the world’s largest stablecoin issuer at that time. John Betts, the former CEO of Noble Bank International, which at one point held Tether funds, further sparked suspicion when he said that:
“It’s not a stablecoin, it’s a high-risk offshore hedge fund,”
Verifying Tether’s USD Holdings
Centralized stablecoins are typically audited on a quarterly basis by an independent accounting firm. Tether now issues a limited “assurance” by an accounting firm listing the assets in its reserves. On June 30, 2022, Tether reported $66.4B in assets backing USDT. Cash and bank deposits accounted for 8% of the reserve, and U.S. government bonds comprised about 44%. The rest was composed of corporate bonds, precious metals, and other assets.
Sam Bankman-Fried, the CEO of FTX, the crypto exchange, FTX CEO, billionaire has expressed confidence USDT will not depeg:
“I think that the really bearish views on Tether are wrong… I don’t think there is any evidence to support them.”
Has Tether (USDT) Ever Depegged?
A stablecoin’s true reserve test happens in extreme market conditions when investors flock to stablecoins to redeem their tokens for fiat currencies. This scenario unfolded after Terra collapsed in early May 2022, wiping out $44B immediately and many billions later through crypto contagion.
Crypto broker Voyager Digital, lending platform Celsius, and crypto hedge fund Three Arrows Capital (3AC) were just some of the multi-billion bankruptcies. The selling pressure did wobble USDT’s peg to the dollar, but only briefly.
Compared to many algorithmic stablecoins, which collapsed completely, USDT’s peg never went below $0.98, which was just under 2% of $1. This happened within a single day, after which the peg stabilized to the usual ~99.99%.
That May spike was worth $10B in USDT redemptions, which means that Tether successfully passed its stressn test.
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.